Sunday, June 21, 2009

The Psychology Of Human Misjudgement: Reciprocation

Charlie Munger is Warren Buffett's right hand man at Berkshire Hathaway. Over the next few weekends, we'll be summarizing the text he authored titled "The Psychology Of Human Misjudgement", where he describes some of man's tendencies. By understanding and learning from these tendencies, we better equip ourselves to avoid psychological biases when investing.

Humans, apes, monkeys, dogs, and other animals all share the tendency to reciprocate. When someone does something nice (mean) to you, you tend to do something nice (mean) to them as well. The tendency fosters cooperation within groups, and also protects groups from the ill-intentioned.

The power of this tendency is strong, and can drive individuals to perform brutal acts. For example, in wars sometimes prisoners are not taken (but rather killed) when one side believes the other side is treating its prisoners unfairly. Non-war examples of disfavourable actions as a result of this tendency are road rage and injury-causing temper tantrums on athletic fields.

Munger notes that, whether good or bad, humans are not programmed to turn-the-other-cheek. The best antitode to falling victim to disfavourable actions resulting from this tendency is to defer reaction. Munger quotes Tom Murphy, whom Buffett has often called one of the best managers alive, who frequently says, "You can always tell the man off tomorrow, if it's such a good idea."

Positive reciprocation is just as strong as well. Marriage and commercial trade are listed as examples where this reciprocation fosters strong relationships. Because it is often a subconscious behaviour, one's tendency to reciprocate can also be taken advantage of. For example, when an automobile salesman offers small favours, you are more likely to accept a final sale price that is $500 higher than otherwise. A man who is spending someone else's money (e.g. the manager of a company, a government employee) are more likely to fall into this trap, since he is not the one who has to foot the bill. Sam Walton (the man who started Walmart) recognized this tendency early, causing him to implement a policy disallowing purchase managers from receiving gifts of any kind from vendors.